Why Gary Cohn Was Right About Tariffs

Of the many Trump lieutenants who’ve departed, no one had a better reason for leaving than Gary Cohn.

Cohn lost a battle with the “nationalist” wing at the White House led by Peter Navarro, President Trump’s top adviser on trade. As the president’s chief economic adviser, Cohn has proven an ardent free-trader who strongly opposed Trump’s plan to impose heavy tariffs on steel and aluminum imports. When Trump took his biggest concrete steps yet to deliver on his protectionist campaign promises, Cohn apparently quit in protest.

Put simply, higher tariffs will prove a burden that undermine the benefits of Trump’s regulatory reforms and tax cuts, two initiatives that have boosted economic growth. By contrast, tariffs work in the opposite direction by imposing what amounts to higher taxes on companies, and ultimately, individuals. Here are the four ways that tariffs harm the economy.

A tax paid by American consumers

The 25% and 15% duties that Trump plans to impose on steel and aluminum imports, respectively, won’t be paid by the foreign producers that manufacture those materials. Instead, they’ll raise prices for U.S. companies that purchase imported steel used in aerospace and medical equipment, petroleum refining gear, heavy machinery, construction materials, and consumer products from soup cans to baby carriages. Companies mostly pass those costs on to households, who effectively devote more of their take-home pay to supporting the 286,000 workers employed in steel and aluminum. The new “tax” on consumers reduces the income they can spend on other products, curbing economic growth.

For many companies, tariffs cut profits

Some companies compete in sectors so competitive that they can only recoup part of the extra costs of imported steel and aluminum inputs. “I’m hearing from two small processors of steel in my district in Texas,” Republican Rep. Jeb Hensarling told Fortune, “one that makes shelving, and one that makes steel buildings. And they’re very concerned that their input prices will go up.” In those basic, highly competitive businesses, it’s likely that only part of those increases will go to prices. The balance will hit profits. And as earnings shrink, companies have less to invest in expansion, hurting job growth.

Protectionism weakens the protected

Though they’ve shrunk in recent decades, the U.S. aluminum and steel industries have survived precisely because foreign competition has forced them to improve. Imposing tariffs that raise the price of imported steel by 25% and aluminum by 10% allows them to once again get lazy, and avoid the tough choices needed to be globally competitive. Over time, the focus of a protected industry turns from constantly improving productivity to lobbying for more and more tariffs. U.S. manufacturers will get weaker and weaker compared to foreign rivals, so any advantages they gain in the U.S. from tariffs will be offset by a decline in their competitiveness abroad. In other words, their foreign profits will probably dwindle more than their U.S. earnings increase.

Tariffs invite retaliation

In themselves, the new tariffs aren’t a huge deal. Steel and aluminum imports combined total $53 billion. So shifting part of that number to U.S. producers, who will charge higher prices on a few tens of billion in sales, won’t sink the economy. It’s the signal that counts most. This is the first time Trump has delivered big time on his campaign pledge to extend broad protections to U.S. manufacturers. If he fulfills the pledges he made as President-elect, the results could be catastrophic. A study by Suffolk University in Boston found that the tariffs he promised as a candidate to levy on China, Japan and Mexico could increase prices to U.S. households by over $2,000 a year for five years.

Tariffs also invite retaliation from overseas. The European Union is already weighing whether to hit a wide range of U.S. exports, from motorcycles to orange juice, with new duties. “There’s no such thing as a good trade war, as the recent history of the Bush administration shows,” says Hensarling.

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The U.S. is benefiting from a surge in optimism, inspired in part by Trump’s pro-business agenda on tax cuts and regulation. Tariffs, however, introduce an alarming note of uncertainty. CEOs don’t know what new inputs will suddenly get more expensive, or if they’ll be hit with heavy duties on cars or refrigerators they sell abroad. Hence, they pull back on expansion.

The threat of a trade war would also freak out the overseas investors we count on to buy our government bonds, and keep our interest rates at super-low levels. If they fear that a retreat from free trade will harm future growth, and our ability to pay them back without resorting to inflation, they’ll demand higher “real” rates on their loans. That in turn would push up the cost of borrowing for businesses, further pounding profits and killing plans for expansion.

As Hensarling says, “Trade isn’t a zero-sum game.” Low cost imports help businesses and consumers a lot more than they hurt workers in those industries. And once again, raising artificial barriers removes manufacturers’ incentive to keep improving, ensuring their long-term decline. Cohn was right. Let’s just hope that others in the White House keep up the courageous fight for free trade.

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